Debt Ceiling Negotiations to End Badly

July 3, 2011

By this time next month, the long-running battle over raising our nation’s debt ceiling will have come to a resolution, one way or another.  Either the U.S. will be forced to default (or not?  see below) or an agreement will have been reached to raise the ceiling in return for a cut in the projected size of the deficit.  Possible outcomes range from a catastrophic global financial melt-down at one end of the scale to a mere collapse into the 2nd dip of the recession at the other end of the scale.  There are no possible good outcomes here.  This is going to end badly. 

Those who have bought into the notion that cutting our deficit, especially by cutting government spending, will somehow stimulate the economy couldn’t be more wrong.  Cutting the deficit, regardless of whether it’s done by cutting spending, increasing revenue or some combination of the two, will take money out of the economy.  Collecting revenue takes money out of the economy as Republicans correctly point out.  Government spending puts money back in, as Democrats correctly claim.  Taking more out in the form of revenues or putting less back by cutting spending leaves the economy with less than it started.  While that helps the nation’s balance sheet in the long run, leaving the next generations better off, it’s bad for the economy in the short run. 

So the only possible outcomes here are either a U.S. default on its interest obligations on its bonds, which could conceivably render all U.S. bonds instantly worthless, wiping out banks and investors across the globe, or a recession-triggering pulling of the rug from under the feet of the U.S. economy, an economy barely kept above water by trillions in deficit spending by the federal government and quantitative easing by the Federal Reserve – all of which has come to an end.  No wonder the two sides are battling so bitterly.  Both know the outcome will be bad.  Each wants the other to take the blame. 

And that’s not the half of it.  Even if a deal is reached, the deficit is cut and the debt ceiling is raised, the only thing that will have been accomplished is that the “can” will have been kicked a bit further down the road.  It’s not as though we’ll be cutting the deficit; we’ll only be cutting the projected growth in the deficit.  The deficit, projected to grow by another $15 trillion or so in the next ten years, will instead grow by only $10 or 11 trillion, a situation that will leave us in far worse shape than now.  What are the odds that it’ll be dealt with then?

I’m not arguing that the problem shouldn’t be addressed or that no good outcome is possible regardless of what our lawmakers do.  The problem is that nowhere in these talks is the real problem that drives the deficit spending being addressed, and that is the trade deficit.  As I said earlier, anything that takes money out of the economy, which includes taxes, cuts in deficit spending – even personal savings, is a drag on the economy.  And our trade deficit currently drains over $500 billion per year from the economy.  If that draw-down from the economy isn’t made up by deficit spending, then economic recession is absolutely unavoidable.  Furthermore, without any deficit spending, then the U.S. will not be issuing any more bonds, leaving foreign countries with trade surpluses with the U.S. no way to plow those dollars back into the American economy, throwing a big monkey wrench into the gears of the global economy.  Ultimately, that might be a good thing, forcing a rebalancing of the global economy and global trade. 

So, without a comprehensive approach to fixing our economy that includes restoring a balance of trade (and perhaps even addressing our goofy immigration policy, but that’s a different topic), merely cutting the deficit and raising the debt ceiling is just another round in a game of economic whack-a-mole, a futile effort to deal with economic side-effects that pop up faster than Congress can swing its little economic mallet. 

Greece is a good example of what we’re facing.  Like the U.S., Greece has a large trade deficit – about the same as the U.S. in per capita terms.  Like the U.S., Greece is heavily dependent on imported oil.  And like the U.S., its debt exceeds its GDP and has been growing rapidly.  The austerity measures imposed upon Greece by its creditors have resulted in violent civil unrest in that nation in recent weeks.  And the Euro zone has warned Greece that it faces loss of its sovereignty and the prospect of much higher unemployment as these austerity measures take hold.  (See http://www.reuters.com/article/2011/07/03/us-eurogroup-greece-idUSTRE76219J20110703.)  The U.S. will face the exact same things if we implement drastic deficit reduction programs without addressing our trade deficit.

Things are coming to a head soon and, regardless of how it turns out, it won’t be good. 

* * * * *

Regarding the whole issue of default, there is a little-known sentence in the 14th amendment that seems to forbid the U.S. from failing to pay its obligations.  That sentence reads, “The validity of the public debt of the United States … shall not be questioned.”  The Obama administration is considering whether, in the event that the debt ceiling isn’t raised, it can invoke this statement and ignore the debt ceiling and continue paying the government’s bills.  Imagine the ramifications.  Without the limitation of the debt ceiling, there will be no rein on government spending.  It would be interesting to see just how fast an amendment to balance the budget, already being suggested by Republicans, would be introduced.  But, again, bear in mind that balancing the budget without balancing trade is a virtual (if not physical) impossibility.  At least such an amendment would pretty quickly force a re-evaluation of trade policy. 

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Is Globalization in Its Final Days?

February 19, 2011

http://news.yahoo.com/s/ap/20110219/ap_on_re_us/g20_finance_ministers

Globalization, a process begun in wake of World War II with the signing of the Global Agreement on Tariffs and Trade in 1947, may now be in its last days.  Whether those days number in the thousands or hundreds is yet to be seen but, make no mistake, the end of global economic cooperation is near.  As reported in the above-linked article about the G2o meeting in Paris, export-dependent nations, lead by China, are dragging their feet on the 2-step effort to measure and rectify global economic imbalances. 

Finance chiefs of the world’s dominant economies on Saturday pressured China to drop its resistance to a deal on tracking dangerous imbalances in the global economy, in an effort to revive the Group of 20 rich and developing nations as the forum to prevent further financial crises.

More than any other imbalance, current accounts (trade supluses and deficits), have taken center stage in the talks.

China has so far opposed targeting current account surpluses — which show that a country sends much more goods and capital abroad than it receives …

But patience is wearing thin.  Global leaders understand that such imbalances were at the root of the economic collapse of the past couple of years and that the capacity to deal with another such crisis has been exhausted.

The stakes are high: French Finance Minister Christine Lagarde warned Friday that a failure to address imbalances “leads us straight into the wall of another debt crisis,” while President Nicolas Sarkozy said that countries must not get complacent as some parts of the world are starting to recover from the crisis while others are still lagging behind.

“That would be the death of the G-20,” Sarkozy warned.

The following is perhaps the most frank admission I’ve seen yet of the role that global trade imbalances played in the global economic melt-down:

What is clear to most economists is that sticking to the status quo could be fatal.

In the years before the financial meltdown of 2008, countries with trade surpluses plowed money into mortgage and other investments in the United States, helping escalate their value, U.S. Federal Reserve Chairman Ben Bernanke told his G-20 colleagues Friday. But the U.S. failed to safely absorb money flooding in from emerging nations like China, Middle Eastern oil countries and industrialized countries in Europe, Bernanke said.

“… the death of the G20.”  “Sticking to the status quo could be fatal.”   Strong words that highlight the urgency.  Bernanke and others know very well that a repeat of the recent economic crisis will be exactly that – fatal.  The global economic system will come completely unglued and it will be every man (country) for himself. 

How much time is left?  That’s the big, unanswered question.  But if recent history is any indication, it’s not long.  Consider this:  the economic bubbles we’ve witnessed in the last two decades have been fueled by the trade imbalances.  American trade deficit dollars have to come back to America, one way or another.  In the ’90s, those dollars bought stocks and inflated a huge stock market bubble.  It took about six years for that to run its course and for the bubble to burst in March of 2000.  Then those trade deficit dollars were funneled into real estate in the form  of mortgage-backed securities.  Once again, it took about six years before that nearly collapsed the entire global financial system. 

It’s now been about three years since that collapse in late 2007/early 2008, and nothing has been done to address trade imbalances.  First, trade dollars inflated a bubble in treasuries – a bubble whose bursting has been delayed by the Fed’s program to buy up new treasury issues.  More recently, those trade dollars are re-inflating another stock market bubble.  History suggests that there may only be another three years to go before the next economic collapse.  If the G20 can’t address these imbalances in a coordinated way, then the U.S. will have to go it alone and do what’s necessary to restore a balance of trade.  It’s that or economic oblivion.

Export-dependent nations, most notably China, will never go along with any G20 plan to rectify imbalances, wiping out their huge trade surplus.  They may play along a bit longer to buy time, but it won’t buy them much.  When time runs out, so too will the global economic engineering that has forestalled the day of reckoning for overpopulated, export-dependent nations.  From my perspective, that day can’t come soon enough.


Tension Over Trade Imbalances Heating Up

November 5, 2010

http://www.cnbc.com/id/40021005

As reported in the above-linked CNBC article, tensions over trade imbalances are heating up, not just in China, as head-lined in the article, but in Japan and Germany as well.  It seems that the U.S. has proposed that other nations “cap” their current account surpluses (trade surpluses) at 4% of GDP:

The United States proposed at the G20 finance ministers’ meeting last month that countries should cap current account surpluses or deficits at 4 percent of GDP as part of efforts to rebalance the global economy.

It was one thing for Obama to suggest at the height of the global economic crisis that nations voluntarily work together toward rebalancing the global economy.  All agreed, knowing full well that there would be no follow-through by the U.S. and they could return to business as usual.  But it’s an entirely different matter for the U.S. to begin insisting on quotas. 

China on Friday pushed back strongly against U.S. policies ahead of the G20 summit, ridiculing Washington’s plan to impose current account targets and warning of risks in the Fed’s monetary easing.

… The idea of numeric targeting met strong resistance from Japan and Germany …

U.S. patience with huge trade imbalances is wearing thin.  Now, even the Fed has joined the fight with its new round of quantitative easing.  If voluntary approaches and pressure on currency valuations don’t work, then the unavoidable question for the U.S. is “what do we do next?”  There are only a couple of options – the ones I’ve steadfastly maintained are the only viable options:  U.S.-imposed quotas and tariffs. 

Forget all the post-election banter about “Obamacare” and about government spending.  It’s all dwarfed in significance by this escalating global war for employment.  The global trade regime set up in the wake of World War II in the hopes of preventing the next war has back-fired and is crumbling, and may very well have provided the catalyst for the next one.


Shocking 2nd Quarter GDP Report Points to Further Recession

August 5, 2010

I posted a few days ago when the 2nd quarter GDP report was released, and promised to follow up when I could get back to my desk and crunch the numbers to arrive at per capita GDP, with and without stimulus spending. 

I was so shocked at the results that I had to double and triple-check the figures!  Remember that the government reported that real GDP (adjusted for inflation) rose at an annual rate of 2.4% in the 2nd quarter, a pretty anemic report.  When expressed in per capita terms, accounting for population growth, real per capita GDP rose at an annual rate of only 1.5%.  But the really shocking news is just how much the stimulus plan spending contributed to that anemic report.  In the 2nd quarter, Economic Recovery Act spending soared to $182 billion, raising the total amount of stimulus money spent so far by 58% in one month! 

It’s important to track what the underlying economy is doing with this stimulus spending stripped away, because the stimulus spending is going to end soon.  If this spending is stripped out of the GDP report, real per capita GDP fell in the 2nd quarter by 3.6%, the worst rate of decline since the economic crisis began in 2008!  Here’s the chart:

Real Per Capita GDP

I can’t account for the explosion of stimulus spending in the 2nd quarter.  It may be due to the homebuyer tax credits that expired at the end of June.  There’s also the possibility that there was simply some “catch up” in reporting in the 2nd quarter.  Regardless, this is an absolutely devastating GDP report and portends extremely serious problems for the economy when the stimulus plan has run its course. 

You may recall that I’ve been predicting another massive stimulus plan to follow on the heels of this one.  But there’s simply no appetite in Congress for passing another.  Well, I read rumors this morning that the Obama administration plans to bypass Congress in August and effectively implement another $800 billion in stimulus by ordering Fannie Mae and Freddie Mac to forgive part of the balance on mortgages that are “under water.”  He can do this without Congress’ approval.   (Here’s a link:  http://blogs.reuters.com/james-pethokoukis/2010/08/05/an-august-surprise-from-obama/)

None of this comes as a surprise.  The stimulus bill bought Obama time to make real fixes to the economy – primarily fixes to our trade policy that would correct trade imbalances and bring home millions of high-paying manufacturing jobs.  But no fixes were made.  Now the stimulus money is spent and there’s nothing to show for it. 

As if the 2nd quarter GDP report wasn’t bad enough, analysts are already expecting a significant downgrade when the next revision comes out next month, lowering their forecasts to 1.7%.  All indications are that the economy is in serious trouble.  Like I said in my last post, look for the economic you-know-what to start hitting the fan in coming months.


Clinton to the Rescue? Yikes.

July 15, 2010

http://www.reuters.com/article/idUSTRE66D1DX20100715?type=politicsNews

President Obama, apparently having emptied his bag of economic tricks with the stimulus package and now bereft of ideas for what to try next, is soliciting advice from former President Bill Clinton who, according to the above-linked article:

… presided over the 1990s economic boom …

and was the last president to turn a budget surplus since Richard Nixon had a miniscule surplus ($3 billion) in 1969.  Never mind the fact that a chimp could have done the same thing in the late ’90s, in light of the stock market bubble, the dot com bubble and the explosion in PC, internet and cell phone technology and manufacturing (all of which has since been out-sourced to China and others).  Clinton was too busy enjoying a fine cigar with his intern to have even known what was going on. 

So what’s Clinton likely to advise Obama to do? Provide more stimulus money for alternative energy?  Give more tax breaks to industry?  Implement more free trade deals?  Yeah, granting China MFN (most-favored-nation) status worked out real well, didn’t it, Bill? 

What’s worrisome here is that this is a thinly-veiled admission by the Obama administration that their economic strategy, having run its course, leaves the economy heading back into a slump, and they’ve got nothing left.  The stimulus halted the slide temporarily, but stimulated nothing.  Now we’re back in the same boat. 

No, actually, it’s worse.  At least before the financial melt-down, we had a housing bubble and easy credit to make us think things were OK.  Now we don’t even have that.  Nothing’s been done about our broken trade policy.  No manufacturing jobs have come back home and global trade imbalances are returning to their pre-crisis levels.  And deficit spending is about as popular as a turd in a punch bowl.

I’m sure we’ll soon see a shake-up in Obama’s economic team.  Summers and Romer will probably be replaced by a couple of other ivy-league economists serving up the same platitudes about economic growth and free trade.  Not that it will make any difference.

I suppose we should be thankful for one thing:  if Clinton weren’t here, Obama would have to turn to Jimmy Carter for advice.


Global Economy’s Achilles Heel: Unemployment

June 2, 2010

http://www.reuters.com/article/idUSTRE6504EU20100601

During the past couple of months, the world has been coming to grips with something that no world political or financial leaders want to admit – the global economy no longer works.  It’s collapsing under the weight of the one factor that economists never accounted for – unemployment. 

As reported in the above-linked article, the International Labor Organization (ILO), an agency of the U.N., is warning that measures being taken by governments around the world to reduce debt will likely lead to a recession, with rising unemployment potentially threatening social stability.  Yesterday, in an about-face from its recent lecturing of the U.S. to get its fiscal house in order, China also cautioned against moves to rein in debt.  (The Chinese are smart enought to know that every dollar or euro cut from government spending in the U.S. and Europe translates into lost exports for them.) 

But financial markets have become absolutely intolerant of high debt levels.  Ratings agencies like Moody’s and S&P, breathing a sigh of relief that they weren’t hammered harder with law suits and criminal prosecution for their role in the global financial collapse that began in 2008, are now ruthless in their slashing of credit ratings for anyone with the slightest potential of default. 

Without deficit spending, the global economy with its requisite trade imbalances doesn’t work.  Without trade imbalances, badly overpopulated nations like Germany, Japan and China face staggering unemployment.  With the trade imbalances, big importers like the U.S. face eventual default. 

The problem is that, with much of the world so densely populated that per capita consumption has been driven into decline, deficit spending is the only thing left in economists’ bag of tricks to prop up consumption and hold rising unemployment at bay.  Globalization is an unemployment sharing mechanism that spread unemployment away from overpopulated economies to the U.S., where gimmicks like the dot-com boom of the ’90s and the housing bubble of the ’00s could keep unemployment swept under a rug for a while.  But that ploy’s run its course.  Now, not all the king’s treasury secretaries or all the kings central bankers can put this Humpty Dumpty together again. 

It’ll probably take years for all of this to play out, but what we’ll see is an intensifying global battle for employment, World War III fought on an economic stage.  It’ll get worse as the world population soars by several billion more.  Whether the war can remain confined to the economic stage without spreading to the battlefield – only time will tell.


Economy Sheds 589,000 Jobs; Unemployment Hits 12.0%

January 8, 2010

http://www.reuters.com/article/idUSN0720304820100108

As reported in the above-linked Reuters article, the Bureau of Labor Statistics (BLS) reported this morning that the economy lost 85,000 jobs in December and unemployment held steady at 10.0%.  But a closer look at the data reveals a much worse picture. 

The “jobs lost” data is based on the BLS’s “non-farm payrolls” report, which shows non-farm payrolls declining by 85,000 in December to 130,910,000.  But the unemployment figure is based upon a broader measurement of employment level that includes the agriculture sector.  By that measure, total employment fell by 589,000 in December to 137,792,000.  So why didn’t unemployment rise?  Because the other component of that calculation – the “civilian labor force” – contracted once again by 661,000 in spite of the fact that the population grew in December by 200,000.  The government has been using this phenomenon of a magically vanishing labor force to hold down the unemployment rate since the onset of the recession in late 2008. 

If we assume the labor force is a constant percentage of the population, then the real unemployment rate rose by 0.4% in December to 12.0%, the highest level since the Great Depression.   And the broader measure of unemployment, which includes those who have given up looking for work and those working part-time when they really need full-time work, rose to 21.3%. 

The following is my calculation of unemployment, using the government’s own data:

Unemployment Calculation PDF

(By the way, if you compare this spread sheet to the one included in my post on the same subject last month, you’ll see that some of the data has changed slightly.  That’s because the BLS revised the data for small changes in population estimates.)

The following is a chart of the same data, just to make it easier to visualize what’s happening:

Unemployment Chart

Notice that the government’s methods for calculating unemployment (both U3 and U6) correlated very closely with my own method until the start of the recession, when the labor force began disappearing. 

Finally, some observations about the December data:

  • The employment level is virtually unchanged from the level in December of 2000. 
  • During that same time frame, the population has grown by 25 million. 
  • In the last 12 months, the employment level has fallen in ten of those months and has risen twice (most recently in November), for a total loss of 5.2 million jobs.  Of those ten months in which losses occurred, the loss in December was the 3rd worst.
  • In the last 24 months, the employment level has fallen in 19 of those months, for a total loss of 8.2 million jobs. 
  • As you can see from my chart of U3a unemployment, contrary to economists who are hailing the slowing rate of job losses, unemployment continues to rise unabated. 

Since the Obama administration continues to sit on its hands when it comes to restoring a balance of trade, none of this is a surprise.  It’s likely to get worse.  Stay tuned.